Instead, I believe in using other levers that can contribute to wealth accumulation for investors, without necessarily increasing risk. In fact, most of these levers help to reduce risk for the investor.
What are these levers that can significantly increase the value of a stock over the long term? I envision at least seven; here they are:
Margin leverage: If a company is currently experiencing significantly lower profit margins than in the past, there may be valid reasons for this. Most sectors become increasingly competitive over time, and it is normal for company margins to be under pressure. However, sometimes a company’s low margins may be temporarily depressed and expected to return to normal in the future.
Strong financial health leverage: We highly value financially healthy companies not only for defensive reasons (a profitable company with no debt and ample cash reserves is unlikely to face issues during an economic slowdown or a crisis like COVID-19). Strong financial health can also be a valuable asset for growth. It allows a company to consider acquisitions, buy back its own shares, or pay dividends – all options that can create value for its shareholders.
Market growth leverage: I prefer a growing sector over a declining one – this preference is natural. Natural growth in a sector represents a significant favorable wind for any company.
Stock valuation leverage: I have already mentioned the combined effect of a company’s earnings per share growth and an increase in its price-to-earnings (P/E) ratio.
Excellent management team leverage: Does the management team enhance the company’s growth potential? Executives who have proven themselves in the past and created significant value for shareholders are likely to continue doing so in the future. Never underestimate the value of an excellent CEO in the long-term appreciation potential of a stock.
Time and compound interest leverage: I have written extensively on this topic; time represents an invaluable lever in increasing your wealth. I’ll remind you of the rule of 72: if you achieve a long-term compounded annual return of 10% with your portfolio (roughly historical returns of North American stock markets), an investor will double their portfolio value every seven years (rule of 72: 72 / 10% = approximately seven years). After 20 years, the value will have multiplied nearly eight times; after 30 years, more than 17 times!
Learning: This is a difficult lever to measure. However, I am convinced that an investor has a duty to continue learning and improving throughout their investment career. I hope I am a much better investor now than I was 32 years ago at the start of my career, and I aim to be even better in 30 years! Every investor should commit to continuous learning by reading investment books, learning from the best investors’ practices, and carefully documenting their buying or selling decisions.
Investors should fully utilize these different levers in their stock selection and portfolio construction.
Philippe Le Blanc, CFA, MBA
Chief Investment Officer at COTE 100
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